Thursday, July 31, 2008

Metaphysics & The Stock Market

The stock market offers some interesting insights into the way our world works right now. Keep in mind the axiom that all things come from either love or fear.

A simple definition of the stock market is this. People buy stock in companies whose product or service they believe to be of quality, with the expectation that customers will continue to buy these products or services well into the future. The company gets money to use for expansion and development and the owner of the stock has some confidence that in the future their share will be worth more. People who invest in small, growing companies with innovative products stand to make the greatest return on investments, for example, companies that make breakthroughs in medical technology or computer technology. Other opportunities for making money on stocks occur when a company produces a good product or service, but for some reason, their stock is trading at a relatively low price. Some of the wealthiest investors have made their fortunes this way.

Now, in recent years, with the advent of day trading, there is a whole different philosophy of making money in the stock market. Day trading essentially means that people buy and sell stocks within the space of one day. Frequently they may buy and sell within the space of an hour or two. Sometimes they buy and sell shares of the same stock two or three times in a day. How do they know when to buy and sell? Some subscribe to newsletters and follow their advice. They act rapidly on these "tips" churning and burning their way through the market, sometimes buying and selling shares of companies whose business they do not even know. The action can go so fast that if you are one of the first to buy and first to sell you might make a profit. If you are behind the herd, you lose. That can also explain why companies that make products that people really want and need might see the price of their stock fluctuate wildly. Newsletters might publish an opinion that the price might rise and fall within a certain range and speculators jump in with purchases that seem to have no basis in common sense. Anyone who cares to research can find companies who produce things that we all use on a regular basis whose stock charts look like a roller coaster. Traders also play a game called short selling, in which they bet on whether or not a stock price will go up or down. Sort of like a side bet at a blackjack table. An observer might question whether these activities are artificial influences on the prices of stocks when these gamblers are pushing the prices up and down absent any reference to the progress of the company whose business those stocks represent.

Old fashioned stock brokers would offer advice to clients and charged a larger fee per transaction, usually relative to the amount traded. Day traders can log on to computers and execute trades rapidly. The mantra is "You can afford to trade as much as you want. Trades are only $10!" (There is also a company where trades are only $7 each). Compared to the old fashioned brokers fee schedules, that is a bargain. But is it really?

Let us use a hypothetical round number for the sake of example. If a person were to start with a $100,000 investment account, and they made 10 trades a day for a year, that would be $25,000 in trading fees. (It is not uncommon for day traders to make 20 transactions a day.) Day traders also typically subscribe to newsletters, which can range in price from hundreds to thousands of dollars each. Let us say this hypothetical subscriber pays $5000 a year.

So at the end of one year of trading, if that person does not have more than $130,000 in their trading account, they have lost money for the year. How hard is it to make more than 30% on your investments in a year? Most people cannot do that. Using this hypothetical example, that is just the break even point. This hypothetical person would have to make 50% or 60% on their original investment to even get a return equal to a person working at a 40 hour a week job at $12-$14 an hour.

So people who choose to do this place a tremendous amount of pressure on themselves. If they make all the right moves at exactly the right times, they can make a lot. Subsequently, people who are day traders can be highly irritated at any interruption, even a phone call from a friend, because it might distract them from their screens and cause them to miss a trade.

Is it love or fear that drives the trading frenzy?

One way of looking at the two systems would be to call the old system investing, and the new system gambling. Is day trading or short selling stocks any different than sitting down at a blackjack table and hoping that the dealer will turn over an ace and a ten for you?

It is true that there has always been an element of gambling in owning stocks. No one could ever guarantee any stock owner a profit from their purchase, but the law of supply & demand could provide you with expectations and reality checks, and a person could have time to adjust their portfolio. Churning and burning shares over and over every day is so often unrelated to the actual supply & demand for the actual goods and services represented by stocks.

One way of viewing love and fear in the stock market is this. When a person invests in a stock because they admire the company and its work, it is an act of love. When a trader frantically jumps in and out of issues all day, it is an act of fear.

There is an old saying among pool sharks: "When a person starts to play with their lunch money, the pockets start to move."

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